Davos16: Latin American countries hit by low commodity prices but their performance is diverging

January 25, 2016

By Ricardo Hausmann

The World Economic Forum in Davos last week gave me the opportunity to reflect on Latin America, its predicament and the lessons we should extract from the region's recent experience. I was asked to moderate a panel of Ministers from the region. Argentina was represented by my friend, colleague and co-author Federico Sturzenegger, the recently appointed President of the Central Bank. Brazil was represented by the newly appointed Minister of Finance Nelson Barbosa. Chile, Colombia and Peru were represented by my old friends and ministers of finance Rodrigo Valdés, Mauricio Cárdenas and Alonso Segura. One reason why I know these people so well is that they all have PhDs in Economics from top universities: two from MIT (Sturzenegger and Valdés), Berkeley (Cardenas), Penn (Segura) and the New School (Barbosa). That means that I know them from the time they were all academics.The session was on economic resilience in light of current events. All countries had been seriously hit by the collapse in their export prices. Copper (important for Chile and Peru) is down by 55% since 2011. Iron ore (Brazil) is down to 1/5 of its 2011 peak. Soy beans (Argentina and Brazil) are at half their 2012 average price and oil (Colombia and my own country, Venezuela) is down to less than 1/3 its 2013 price.

Interestingly, Chile, Colombia and Peru have all maintained positive growth between 2 and 3 percent, not as rapid as during their previous period, but a remarkable performance given the magnitude of the shock. How did they achieve this? Part of this was the prudence with which they managed the boom: they all reduced their debt/GDP ratios and improved their credit ratings. Chile famously put money aside in its copper fund and its budget institutions were ideally designed to deal with commodity booms and busts. Nevertheless, it was forced to tighten fiscal policy in the downturn, although less than what it would have otherwise required.

Peru has been much more resilient than I expected it to be, given the importance not just of mining exports but also of mining investments, which are now being drastically cut back. It has been able to use fiscal stimulus to lessen the impact, while maintaining fiscal and external deficits at modest levels.

Colombia has been able to keep growing although it has had to do more fiscal adjustment than the others. The tax contribution of the oil industry this year will be zero and to keep the deficit within the fiscal rule the government has had to tighten. Growth will be stimulated by significant investments in infrastructure that will be executed through PPPs and by continued private housing construction, with some public incentives. However, the current account deficit remains very wide. In spite of its many trade agreements, non-oil exports have not yet responded, suggesting that more thinking needs to be dedicated to this issue. Part of the problem is that Colombia's two main neighbors and natural markets (Ecuador and especially Venezuela) have been imploding.

All three countries benefited from their currency regime: floating with inflation targets: they have allowed their currencies to depreciate a lot (~30-%) without jacking up interest rates and with very small inflationary effects. This has also cushioned exporters from the decline in their dollar price. In sum, not bad given the tough times. They all need to do more to stimulate non-resource based exports with productive development policies that they have yet to deploy fully.

At the other extreme, Brazil is in a very vulnerable spot. It is in a vicious circle of low growth, higher fiscal deficits (because of low growth), higher interest rates (because of the large fiscal deficit), leading to lower growth and higher fiscal deficits (because of the higher interest rates and debt service). Tax rates and revenue are at record highs for a developing country meaning that further tax increases may not be the right long-term solution, although the government is trying to bring back the tax on financial transactions. The government has been cutting discretionary spending but constitutionally or legally mandated spending is going up, making it very difficult for the government to rein in the deficit without legal changes. But here, Dilma's political weakness makes the situation that much more difficult as it is unlikely that she can muster the support to approve any new laws. Barbosa argued that this would be the first time since the 1930s that the country undergoes to years of negative growth each in the 3 to 4% range and that this may force politicians to cooperate. How did Brazil get into this pickle? By wasting its commodity and political capital boom in a public consumption spree that did not address the country's problems. It now is forced into a contractionary pro-cyclical adjustment.

Argentina has already seen 4 years of no growth and the IMF projects negative growth in 2016. But Federico Sturzenegger thinks that the unification of the exchange rate and the elimination of chavista-like controls on the economy will cause capital to come back and investment to boom. There was certainly a lot of excitement in Davos about the new possibilities in Argentina.

As a Venezuelan, all of these performances are so much better than what is is store for my country in 2016, where an economic collapse and a humanitarian crisis remain the baseline scenario.

What lessons can we extract of all this? What is clear is that there is a certain anti-market Latin American left that looked attractive during the boom but that has bequeathed a mess. The Kirchners, Lula-Dilma and Chavez appeared not only right politically but also right economically for a long time. They grew more than their predecessors and described their better performance as caused by their superior ideology and social concerns. The 1990s was all caused by the rise of a bad ideology: neo-liberalism. In reality, their predecessors had to deal with an environment which was as tough or tougher than the present and had to make difficult choices. Now we know that the Kirchners, Lula-Dilma and Chavez were only wasting a boom and bequeathing a mess that will also require difficult choices. The approach followed by Chile, Colombia and Peru now looks, with hindsight, as the socially progressive and responsible thing to do. May we all learn from these experiences.